Reserve Bank expected to hold rates on Thursday

Economists say a 4% annual inflation rate that may peak at 5% will not prompt the Reserve Bank to hike the official cash rate on Thursday.

The Reserve Bank is expected to hold the official cash rate at 3% and to keep to the script of its December statement, economists said.

It seems odd to hold rates when inflation is high and rising as monetary policy is supposed control inflation but the inflation rate reflects the one-off price spike due to the good and services (GST) tax increase and other government policy changes.

Westpac economists note that fuel prices are rising, and food price inflation will also need to be watched closely in 2011.

"But setting these factors aside, this is not an economy that's generating a lot of inflation under its own steam right now."

Westpac can ferret out some positives in recent economic data like an improvement in business confidence in the fourth quarter, a pickup in consumer confidence in January, signs that the housing market is stabilising, a rise in job advertisements, a return to growth in the manufacturing sector, and fresh record highs for export commodity prices.

But the biggest item of economic news late last year was a shock fall in gross domestic product of 0.2% in the September quarter.

It provided a weak starting point for the Reserve Bank to work from and is seem as a "trump" factor in the Reserve Bank's analysis.

ANZ said that the combination of recovering demand and rising inflationary pressure from the likes of food and energy prices is expected to necessitate the withdrawal of monetary policy stimulus from mid-year.

"However, this remains contingent upon the world scene holding together. At present the United States looks to be recovering a bit more quickly than expected, but sovereign risks remain in Europe and inflationary pressure is going to create business cycle challenges for Asia. The bumpy ride is expected to continue."

Goldman Sachs said the economic data has vindicated the Reserve Bank's dovish stance in its December monetary policy statement.

"As a result, we expect a similar cautious message to be delivered," Goldman Sachs said.

ASB said that the underlying trend in retail sales data released on Friday was weak.

"This adds to the recent softness in activity data, and with inflation pressures contained for now there is little urgency for the Reserve Bank to resume the reduction of monetary policy stimulus.

"We expect the Reserve Bank will leave the official cash on hold until the September meeting.

Westpac also expects a September hike with the risk tending toward a hike later than that rather than earlier.